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Providing coverage of Alaska and northern Canada's oil and gas industry
September 2007

Vol. 12, No. 35 Week of September 02, 2007

E&P companies have reserve worries

Just-released John S. Herold upstream survey confirms finding of earlier surveys: worry over ability to replace spent oil reserves

Ray Tyson

For Petroleum News

The latest upstream survey reflects what other independent surveys released earlier this year discovered: the ability to replace spent oil reserves, despite record capital investment, has evolved into a major concern for many exploration and production companies. A huge increase in operating costs also is pressuring companies.

Worldwide upstream investment of 228 oil and gas companies increased 45 percent to a record $401 billion in 2006, according to the 2007 Global Upstream Performance Review released Aug. 29 by oil and gas research firm John S. Herold Inc., an IHS company, and upstream corporate advisor Harrison Lovegrove & Co. Ltd.

However, all that spending last year generated just a 2 percent increase in reserve volumes to 263 billion barrels of oil equivalent, while reserve replacement costs climbed 33 percent to $13.60 boe.

“The key challenge facing the petroleum industry continued to be replacing reserves and growing production due to the combination of maturing basins and reduced accessibility to new acreage,” Martin Lovegrove, Harrison Lovegrove’s chief executive officer, said, noting that “with opportunities scarce,” proved and unproved acquisition costs last year increased 85 percent, while the “implied costs” for the acquisition of proved reserves soared 55 percent, more than twice the increase in oil prices.

Robert Gillon, Herold’s senior vice president and co-director of Equity Research, said that growth more than offset higher operating expenses and increased taxes, allowing the industry to report $243 billion in net income, the fourth consecutive record.

“But rising costs are pressuring investment returns, as net income as a percentage of the book value of oil and gas assets declined in 2006 following three years of gains,” he added.

Shareholder returns robust

Still, the Herold-Harrison Lovegrove study found that returns to oil industry shareholders during 2006 were robust: dividends reached a record $83 billion, up $7 billion, while share repurchases increased 37 percent to $88 billion. Combined, the returns to shareholders accounted for 55 percent of net income. However, over the last two years, industry laid out more to repurchase its own shares than it did to acquire proved reserves.

The 2007 Global Upstream Performance Review, the 40th such annual study of 228 public oil and gas companies based on data filed with the U.S. Securities and Exchange Commission and other similar agencies worldwide, measured industry performance in a number of key areas.

For example, worldwide revenues last year increased by $134 billion, implying an average realized price of $43.62 per barrel, a 16 percent increase from 2005. Cash flow increased 18 percent to $391 billion, more than double the 2002 results. But industry investment exceeded cash flow for the first time since 1999 on a flurry of North American acquisition activity.

Development spending increased 29 percent, but accounted for 52 percent of total investment, down from the five-year average of 58 percent. Exploration spending increased 39 percent, the largest jump in five years.

A nearly 80 percent increase in proved acquisition spending produced just a 15 percent increase in purchased reserves. Investment in unproved acquisitions almost doubled to $47 billion and has increased four-fold since 2002.

The United States and Canada were net consumers of capital, while Asia-Pacific generated the largest free-cash flow of any region for the third consecutive year.

Oil reserves increased just 1 percent on a 1.9 billion barrel increase in Canada, mainly oil sands related. Natural gas reserves and production continued at the 3 percent growth rate of the last four years.

Replacement rates increased modestly in 2006 despite the growth in upstream investment. Finding and development costs surged 29 percent to $14.42 per boe, as the industry replaced just 111 percent of production through the drill bit.

A 31 percent rise in lifting costs consumed one-third of the increase in realized prices, while income taxes were up 12 percent. As a result, cash flow advanced only 18 percent compared with an average gain of 26 percent for the 2002-05 period.

Net income was up 17 percent compared with a 46 percent gain in 2005. Margins were lower after rising for three years, the survey found.

2007 regional findings

Key regional findings of the 2007 Global Upstream Performance Review are:

• The United States was the only region in which profitability declined as finding and development costs nearly tripled and reserve replacement costs soared 83 percent.

• Oil reserves and production in Canada continued to climb, but natural gas languished as investment was directed to oil sands development.

• Oil and gas reserves in Europe are dropping sharply as cash flow exceeds capital spending, but new North Sea projects should help stem the decline.

• Capital investment in the Africa and Middle East region is being redirected toward exploration and acquisitions as proved reserves continue to decline.

• Asia-Pacific is the most profitable region due to relatively lower costs and tax rates, but lower rates of reinvestment indicate opportunities are constrained.

• Oil and gas reserves in South and Central America continue to fall as production flattens, but profitability more than doubled as costs were contained.

• Government take in the Russia and Caspian region is high and rising, limiting profitability, but the resource potential is so substantial that capital investment is growing rapidly.

Earlier surveys

Earlier surveys conducted separately by Energy Intelligence and KPMG in the spring confirmed some of industry’s worst fears — most notably the fact company executives now overwhelmingly believe the world oil supply is being consumed faster than it can be replaced.

“These executives are deeply concerned about declining oil reserves, a situation they see as irreversible and worsening,” said Bill Kimble of audit, tax and advisory firm KPMG, which polled 533 financial executives in April on a number of energy-related issues.

When executives were asked about their upstream capital spending in a 2006 survey, the majority indicated that investment would be a factor in helping them manage declining oil reserves. Sixty-nine percent said that it would increase by more than 10 percent, a jump of 49 percent over 2005.

The world is currently producing more oil annually than it is replacing with new reserves, Energy Intelligence concluded in its study. In contrast to the gradual rise in global oil reserves that has been reported annually in most surveys based on public sources, the firm said, the new assessment showed that the trend in worldwide liquids reserves is actually one of “stagnation and modest decline.”

The PIW Reserves Survey showed global oil reserves declining by almost 13 billion barrels, or 0.9 percent, over the previous two years. For 2006, the big increases in reserves were led by Brazil and Kazakhstan. But among the top 20, only eight countries saw increases last year, while the rest were flat or in decline. PIW attributed the poor performance in growing reserves to a lack of additions to reserves from new discoveries, which accounted for 20 percent or less of additions in the last few years.

Still, Lehman Brothers’ worldwide mid-year survey of 350 companies showed that the upstream on average is expected to boost capital spending by 13 percent in 2007 compared to 2006, up 4 percent from Lehman’s initial forecast of 9 percent.






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